Real Estate Bubble: Fact or Fiction?

The real estate market buzz across the country these days revolves around the anticipated and much feared "bubble". The implication is that once burst, prices will spiral downward taking with them the major assets of those foolish enough to buy at a time when disaster looms large. It could happen.

However, it would take a major cataclysm in the underlying financial underpinnings of the global economy. Granted, any significant blow to world confidence in the fundamentals of the U.S. economy could easily check the flow of overseas investment into the long-term securities markets. The result would likely be a sudden spike in mortgage interest rates. This most likely would spell the end of the present bull market in real estate.

The profits of doom, meanwhile predict just such a meltdown, citing the trade deficit, the national debt and the debt future generations will owe to Entitlement, to name a few. This too could happen. No one knows for sure. We are in uncharted economic waters, where past experience or interpolations from other countries' issues do not necessarily apply. (see Greenspan's Conundrum: mises.org/story/1859)

But what if it happens? In the worst case scenario, assets such as real estate would be the last resource to vanish-not the first--largely because of widespread laws to prevent foreclosure except in extreme cases. Most likely, we would simply have reached another top in the normal real estate cycle, not unlike any of the 21 cycles that have occurred since 1978.

Busts do not usually follow booms. In only 17% of the cycles noted above did a real estate downturn follow on the heals of a boom-and these typically in areas that had experience significant distresses to the local economy. (see FDIC fdic.gov/bank/analytical/fyi/2005/050205fyi.html)

Safe Prediction: In the years since I was first licensed as a RealtorŪ I have experienced all 21 of the full cycles noted above. When I was a new license I too anticipated "The Big One" where the bottom would drop out of the market permanently. Now I know that view is mere paranoia. People are not going to forego living in houses; real property will always have solid value, and the pendulum swings both ways.

"Lies, Damn Lies, and Statistics", as Mark Twain said. Nowhere is this more evident than the real estate market. Statistics that are used to show loss of value mostly show reductions in the number of sales.

Let me explain: while the mean average or the medium sales price of all home sold in a given period fairly accurately represent rises in home prices in an seller's market they do not, paradoxically, reflect the apparent drop in prices experienced in buyers market.

The unassailable law of Supply and Demand states that as prices rise fewer and fewer people can afford to buy. This creates a market glut.

When a glut occurs sellers must contend with greater competition from other sellers. Those that lower their price sell. Those that do not or cannot must stay.

(This has yet to happen. see David Lereah of National Association of Realtors: realtor.org/Research.nsf/Pages/housingoverview?OpenDocument)

The result on market statistics, however, is that the dollar amount of those homes that do sell by lowering their price effect a statistical drop in the apparent overall market prices.

The news that prices appear to be falling further exasperates the situation as buyers feel the need to protect themselves from the perceived downward trend by only investing in properties that are seen as solid bargains. Again, only those that choose to sell or must sell make up the ever downwards statistical spiral.

What is not figured in the averages are the majority of homes that do not sell because their owners are not desperate enough to take what they can get. Their value remains intact.

What falls is not value but volume. Especially in today's market where 100% or greater loans are common, few homeowners will choose to bring money to the closing to table to make up the shortfall between what they owe and what they can sell for at that point in the cycle-in essence paying someone to take their home. And though this scenario may cause hardship, it also has the effect of limiting the number of homes on the market, which acts as a downward buffer to the bottom actually falling out, though statistics may even indicate a continued downward trend.

If it doesn't stop raining it will be the first time. I tell my buyers to only buy if they feel confident that they can remain in the home at least seven years to ride out (in comfort) the coming down cycle. If, during this time, they are forced to sell (usually because of an employment or domestic issue) they could get hurt.

I tell my sellers not to try to predict the exact market top and to watch the rate of foreign investment for signs of weakness that may signal a lack of confidence in the U.S. economy and the rise in home mortgage interest rates that will likely turn the market. No one knows when and if this will occur. But the market will eventually turn. At least it always has.

What to do now: Those that buy wisely, and who can choose the point in the natural cycle to sell, are far more likely to make money than in most other forms of investment. All this while enjoying the fruits of homeownership.

In addition, they will benefit from major tax advantages and the eventual equity value of their home, which will not always rise astronomically but will always rise in the long run.

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